Monday 28 October 2013

Responding to Risk with Intelligent Analytics

By Joe Budden

Following the financial crisis of 2007-2008, many veteran traders were faced with a totally different financial landscape in which to operate. The ‘New Normal’, a term first coined by Pimco trader, Mohammed El-Erian, became the finance community’s go-to word for a new world order which bore more similarities with the post Depression era than anything investors had previously experienced.

This ‘New Normal’, characterised by persistently sluggish growth, high unemployment and political wranglings over debt ceilings and budget deficits, is now five years on and shows no sign of abating.
But it is not only political parties that stand to lose from this new period of economic stagnation.
Financial markets, as a result of huge injections of artificial liquidity from central banks, now reside atop a mountain of debt and are precariously placed should we see any reduction in liquidity or future drop in growth.

Indeed, it could be argued that the super loose monetary policy used in response to the biggest recession since the 1930’s has actually heightened risk, and the resultant artificial rally in global stock markets has created a world in which markets are now scarily dependent on the money flows from central banks.

Much like an addict becomes dependent upon a drug, the financial markets have become dependent on the monthly injections of quantitative easing from the Federal Reserve, and it is for this reason that every FOMC meeting is now watched with baited breath by most traders.
And just like the symptoms of withdrawal when such a drug is taken away, the potential for significant market volatility is profound and something that every investor and trader should be prepared for.

The next shock to the system: Inflation

At the heart of the problem financial markets face is a battle between stagnant economic growth and the coming onslaught of inflation, brought on by years of easy money. Normally this would not present too much of a problem since periods of economic stagnation can be easily prodded into life by central bank intervention.

However, to believe this is to forget that the central banks have now used up all of their bullets. Indeed, central banks now sit on a mountain of debt with no alternative but to scale back, or ‘taper’ as the Fed like to call it - rhetoric that has already caused significant turmoil in stock markets over the last couple of months.

And with the prospect of future unwinding, the already fragile growth picture seen in most developed nations, has the potential to stall even further. (Indeed, recessions typically occur every 4-6 years in developed countries meaning we are now overdue.)

Could the next crisis be worse than ‘08?

Such deficits need austerity, not additional debt, which is why when the next slowdown comes, as it surely will, the financial comedown is likely to be as severe if not worse than that of 2007-2008. Central banks cannot inject any more liquidity because the debt is too big, and they cannot cut interest rates because rates are already at zero.

You can see now why the propping up of huge, failed institutions is rarely conducive to a smooth running financial system.

Obviously, such heightened risk requires a requisite response that is tailored not only to protect capital but to take advantage of such risks and it is here that investors must seek out the tools that will enable them to survive during such a scenario. New regulations and compliance also mean that traders need to operate in a new, more tightly controlled environment.

Weathering the storm with intelligent analytics

The internet has brought with it many advantages, however, the world we live in is now faced with information overload and a rapidly changing business environment. For financial markets, this means new risks - long tail events, flash crashes - as well as new opportunities such as social trading.

More than anything though, traversing the new world with its glut of information, requires ever more sophisticated tools to analyse data, discover new metrics and respond to them in a timely manner.
Which is why in this changing environment, it is not enough to simply rely on the tools of yesteryear, no matter how successful they may have been.
For one thing, the ‘New Normal’ is not a world that anyone knows, and for another, new regulations mean that the trading environment requires more sophisticated and more controlled measures.

Indeed, in order to navigate the coming volatility, new analytics will become ever important;
Back-testing and stress-testing, systems developed with GIPS compliance in mind, forensic bond analysis and measures for liquidity risk as required by UCITS IV.

Such systems (and they are already coming into existence, i.e. StatPro Revolution) will be located in the cloud by necessity and will offer daily risk reports and up to date leverage analysis. This is technology that enables investors to adjust their portfolios systematically and to optimise risk based on their own metrics. Technology that will be the future of data processing across all industries, not just finance.

The next phase

However, just as information will need filtering, markets will need overseeing, and as the Fed begins to unwind it’s aggressive monetary policy, the ‘New Normal’ may well give way to a new type of order - a world where information is likely to be the next hot commodity. We may be already seeing this shift taking place.

Any technology that allows the efficient processing and analysing of such information will be worth more than its weight in gold.

Joe specializes in writing for the finance industry and has written articles for numerous offline and online publications. He takes special interest in trading techniques, technical analysis and the psychology of trading.


  1. I'd rather read about your own research and thinking than Yet Another View From a Crystal Ball by a professional pundit, RIT. I don't think this will influence my investments at all!

  2. Yeah this article didn't add much unfortunately :(

  3. Many thanks for your feedback on what brings you value Anon 1 and 2.

    In recent times you will have probably noticed some subtle changes to the site which are aimed at trying to bring more value (new learnings that can be understood by more readers) and readership (increased readership brings more opinion for us all to learn from).

    The first of these has resulted in me reducing the number of detailed quantitative posts which have been replaced with more general qualitative posts which cover topics that are close to me. I received no feedback on this change but I've still taken it as a positive given that comments, readership, RSS subscribers, email subscribers and Twitter followers are all up significantly.

    For some time now I've tried to encourage readers to submit both good and bad stories (if interested email me at contact dot retirementinvesting at gmail dot com) so that we could all learn from "the many" rather than just a single individual. This was one of the aims of the blog when I first set it up, build a community, but one which I have failed to meet. Some readers have generously donated time and shared for which I (and I'm sure others also) am very grateful however unfortunately it was only a few. I therefore thought that bringing in some external viewpoint might be the next best thing. 2 "complaints" compared to the number of people who have now read this post suggests it still might be.

    Thanks again

    1. RIT, you been replaced by space aliens?

      Joe's entitled to his POV of course, and it's your blog so what you sez goes. But what I value is your take. I'm a big picture sorta guy, and. let's face it, at times irrational as hell, unlike your good self. Your compass always knows where North is.

      But I know what my values are. And so do you. Just sayin' even if I don't look so pretty in a sheet ;)

      Oh and as for Stat Pro Revolution etc - when you need it it will be like a flawed sword - it will fail you when you need it most. Kipling nailed it with his turning gyre. The falcon will be out of touch with the falconer when these information processing .systems will be called upon to navigate the choppy seas. Warren Buffett didn't buy BoA or Burlington or Tesco because he had cloud ;) He did it because he knew what the world looks like when shit goes down. And was rich enough to take a flyer on it...

    2. Kipling; darn - Yeats of course

  4. I see your and other blogs as part of my "university" path towards Financial Independence. I'm more than happy to be given a free reading from any crystal ball; the more the merrier, for then I can use my own goldfish bowl to plot my future path. Keep up the great work, I really appreciate it.

  5. I'm afraid I've also had a negative reaction to this article. It seems to be nothing short of product placement, with Mr Budden's financial relationship to your and/or StatPro not clear at all. I also don't like the undercurrent that seems to be suggesting you need experts to help you because 'this time it's different'. Presumably the experts won't be providing their information for free.

    Website traffic isn't everything - I seem to remember reading that mailonline is the most popular website in the UK and that's not something to aspire to.

    Having said that, I quite like the reference to a possible further financial crisis and the risk of inflation. I happen to believe an inflation shock is inevitable, that it will hit equities almost as hard as bonds, and that property will be a key inflation class required to protect wealth.

    So it's great to see that such controversial opinions are allowed on RIT when a site like Monevator is starting to crack down on the dissenting views.

  6. Hi RIT
    We all have to make a living, so the occasional promo post is okay I guess. However please don't take my lack of feedback on your usual fare as lack of appreciation. I come to this blog for your view, and this is the reason I will do so in the future, if I comment or not! I suspect there are others also with this view.

    I gave StatPro a minute of my life to view the buzz-word-bonanza video, but it did not give my much visibility of the offering, so I could not tell if it would have any value for me. I already subscribe to a good (the well known one!) cloud based stock analysis, screening and portfolio analysis service so I will stick to this.

  7. I am actually disappointed to see this on RIT. What I like about RIT is that it is not trying to be a 'me too' personal finance site, with lightweight syndicated content often with a hidden agenda, but actually presents a pretty much totally transparent view.

    While I don't comment on every RIT post I do read them and appreciate the approach you usually take enormously.